November 18, 2010

Despite the economy's seemingly poor condition, the stock market is moving upward. One of my acquaintances insisits that what is driving the stock market is not economic growth, but the maturing baby-boomer's need to put their money "somewhere". In other words, the retirement money in 401K's by the soon-to-retire population bulge known as the baby-boomers is driving the stocks, not value. Any truth?

My response: No, not if by that your friend means that the shift in investment funds itself is what is driving the stock price up.

What drives any stock's price, and thus all stocks' prices, is the market's assessment of the current value of its future profit stream, discounted for risk and time. If a stock's price goes up, this means that the marginal investor expects the firm's profits per unit risk to rise. It can be due to either firm-specific developments or to economy-wide developments which affect the firm's revenues, costs, or risks.

Just because there is "more money invested" does not mean that stock prices will rise -- the act of choosing to buy a stock does not make the management of the company smarter, or its production processes better, or its cash flows less risky. But the belief by the market that the company is smarter, more efficient, or less risky will, when investors trade on that belief, cause its stock price to rise.

Think about this issue at the level of the individual transaction: what would make you willing to pay $10 for a share of XYZ, Inc. instead of $9? If you believed that you would get a higher return on your investment, even after paying a higher price. You see higher profits per unit risk in the future of this company, or you follow the investment strategy of someone who expects good things of this company. It is the forecast of higher cash flows and/or lower risks that generates the demand and encourages investment, not the size of the pile of money being invested.

November 17, 2010

Reader Randy Tanner asks "Is Bernanke the problem?" in response to a recent article by Vasko Kohlmayer titled Why Isn't Peter Schiff Head of the Fed? In that article, Kohlmayer makes the case that over the period 2002-2007, while Ben Bernanke was saying that the economy was strong, Peter Schiff was warning us about the coming housing bust, rising unemployment, and falling dollar.

The short answer is no, Bernanke is not the problem, not in the way Kohlmayer implies, at least. The Fed did not cause the financial crisis. I personally do not like everything about the way the Fed responded to the crisis, in particular their purchase of toxic assets, but they did not cause the crisis.

And, no, Schiff should not be running the Fed, even if I believed that successfully predicted falling housing prices, rising unemployment, and a weak dollar. Which I don't. But again, not in the way you might think.

Being a good economist does not require one to predict the state of the economy during a certain window of time. In fact, the very best forecasters know to not even try to predict economic activity beyond the next quarter.

No, what good economists understand is cause and effect, and most of that occurs at the level of the firm, the consumer, or the transaction. Extrapolating that to the level of the economy involves so many countervailing factors that "predicting" what will happen at the macroeconomic level is not really meaningful. In other words, you can find someone out there at any point in time making predictions about macroeconomic outcomes who will end up being "right." Eventually. On some level. And this does not help us to make better policy, to allow the economy to be as healthy and productive as possible.

Let me give you a specific example to help make my point. And I agree at the outset that Randy's point is a difficult one to argue against, and that my point is fairly subtle. What I believe was perfectly predictable was the impact of the political decisions that mandated easier and cheaper access to home ownership, and charged Fannie Mae and Freddie Mac with implementing those policies. When the government inserts itself between suppliers and demanders, as it did with these policies, it distorts the price signal and gets either too much or too little of that economic activity.

So what happened here? Because of the mandates, banks made loans to individuals that they would not have otherwise, largely because Fannie Mae and Freddie Mac were standing in the ready to buy those mortgages from the banks and get them off the banks' books. So the banks did not have to bear the risk of those homeowners defaulting on the loan. Therefore, those mortgages were underpriced. And if the interest rates had been higher, where they should have been, less creditworthy individuals (which include high income individuals overextending themselves with a second mortgage as well as low-income individuals overextending themselves with too much house) would have not have applied for the loan in the first place.

If you lower the price of an activity, the demand for that activity rises. So the mandates led to a situation where a larger-than-sustainable fraction of existing mortgages were high risk, were susceptible to foreclosure should the economy take a turn for the worse. THAT is what is predictable, not that the economy in fact took a turn for the worse.

Left to their own devices and profit-incentives, banks are perfectly able to price mortgages and absorb the risk that a fraction of those mortgages will go belly up. And the private economy is perfectly well equipped to pool those mortgages, combine the funds, and issue and fairly price various mortgage-backed securities.

The problem centers on the fact that a politically motived player in the form of Fannie Mae and Freddie Mac used our tax dollars to pursue a social agenda instead of a dollar of profits. Mr. Schiff seems to overlook this fact as a primary contributor to the financial crisis, and Mr. Bernanke, though I suspect is fully aware of the issues surrounding Fannie and Freddie, is not responsible for what Fannie Mae and Freddie Mac do, and must enact predictable monetary policy regardless of their actions.

Again, I do have issues with the Fed's actions over the last few years, and I do worry about inflation and the loss of autonomy of the Fed to the brutish attitude of the Treasury, but those are separate issues in my mind from the supposed ability of Mr. Schiff to predict the housing crash and the financial crisis of the recent past.

It is possible to flip ten heads in a row; unlikely, but possible. And the 10th toss does not predict the 11th. They are independent events. Predicting the 11th toss based on the preceding 10 makes as much sense as predicting that housing prices will fall because they are now high. Neither prediction is based on economics. But when you use tax revenues to subsidize high-risk mortgages, economics correctly "predicts" that more foreclosures and financial distress will occur than would have otherwise. That's a prediction you can count on.

Well. we now see what can happen when you put a terrorist on trial in civilian court: they get away with murder or, in this case, terrorism! The terrorist was acquitted on all but 1 of 281 separate charges or murder and conspiracy in the 1998 bombings on the U.S. Embassies in Kenya and Tanzanie that killed 224 people. Why? One reason must be that the judge in this case had to throw out the testimony of a key witness because that witness' name came to light during military interrogation.

I wrote on this topic, if not this specific case, on two occasions about a year ago on www.learningfromdogs, a website where I am a guest author on subjects beyond economics and finance. I am reposting them here.

From January 18, 2010: In an earlier post, my colleague Paul Handover left us with an important question: Does the public’s lack of clarity about the “underwear bomber’s” status as an enemy combatant or a criminal undermine the appearance of impartiality of the U.S. judicial system?

US Attorney General Eric Holder

Paul reviewed the legal development of the “enemy combatant” designation, ending with a March 2009 pronouncement from Eric Holder, the current U.S. Attorney General, that the U.S. had abandoned the Bush administration’s use of the term. Mr. Holder continued, “As we work toward developing a new policy to govern detainees, it is essential that we operate in a manner that strengthens our national security, is consistent with our values, and is governed by law.”

A new policy that “strengthens national security?” I think it is blatantly clear that an intense and timely interrogation of the bomber does more to protect our national security than lawyering him up and giving him the right to not speak. As you read this, Michael Marinaccio, an attorney for Zarein Ahmedzay, who is suspected of plotting a terror attack on NYC, is seeking to have all the information gathered by officials after his client was represented by counsel thrown out as illegal, under the civil and criminal law of the U.S. We can likely expect the same in the underwear bomber case.

A new policy that is “consistent with our values?” Treating terrorists as terrorists is perfectly consistent with my values. I am not sure what he is trying to say here. Then again, maybe I do know what he is trying to say: that it is “wrong” to treat a terrorist as an enemy combatant, and “right” to give that person all the rights of a U.S. citizen, including the right to an attorney and the right to remain silent? Those may be Mr. Holder’s values, but they aren’t mine and, as you’ll see below, they are not those of the former U.S. Attorney General either.

A new, as yet undetermined, policy that is “governed by law?” This coming from the same legal mind that decided to try the five 9/11 terrorists in New York City federal court? A decision based on what legal precedent? There is no legal precedence. On what existing, well-formulated policy? There is no such policy.

Mukasey, US Attorney General 2007-2009

But on the legal subtleties surrounding this issue, I defer to Mr. Michael Mukasey, a former federal judge who oversaw cases relating to the 1993 World Trade Center attacks. Mr. Mukasey was the U.S. Attorney General from 2007 to 2009 before retiring and being replaced by Eric Holder. His analysis is as follows:

Had Abdulmutallab [the alleged underwear bomber. Ed.] been turned over immediately to interrogators intent on gathering intelligence, valuable facts could have been gathered and perhaps acted upon. Indeed, a White House spokesman has confirmed that Abdulmutallab did disclose some actionable intelligence before he fell silent on advice of counsel. Nor is it any comfort to be told, as we were, by the senior intelligence adviser …that we can learn facts from Abdulmutallab as part of a plea bargaining process in connection with his prosecution…Holding Abdulmutallab for a time in military custody, regardless of where he is ultimately to be charged, would have been entirely lawful—even in the view of the current administration, which has taken the position that it needs no further legislative authority to hold dangerous detainees even for a lengthy period in the United States … What the gaffes, the almost comically strained avoidance of such direct terms as “war” and “Islamist terrorism,” and the failure to think of Abdulmutallab as a potential source of intelligence rather than simply as a criminal defendant seem to reflect is that some in the executive branch are focused more on not sounding like their predecessors than they are on finding and neutralizing people who believe it is their religious duty to kill us. That’s too bad, because the Constitution vests “the executive power”—not some of it, all of it—in the president. He, and those acting at his direction, are responsible for protecting us.

On February 9, 2010, I wrote the following, again on Learning From Dogs:

The debate about the Christmas Day Bomber continues. The pundits continue to define “success” in this case as finding him guilty in a court of law. They go on and on, repeating over and over again, how the evidence is so strong, how the civilian court system is so reliable, how the shoe bomber was tried in civilian court, and how a guilty verdict is virtually certain.

This is so wrong. The definition of success is not whether we find the Christmas Day Bomber guilty in a civilian court. This man intended to blow himself up on Christmas Day, and take hundreds of innocent Americans with him. The fact that he is alive today, facing a jury or a judge and possible jail time or, at the worst, the death penalty, is a mere footnote to him.

Has it occurred to anyone that if the military had interrogated the shoe bomber as the failed terrorist that he was, that the odds of the Christmas Day Bomber getting on that plane with those explosives would have been diminished? And interrogating the Christmas Day terrorist instead of shipping him off to the local prosecutor — for reasons Eric Holder, the U.S. Attorney General, has yet to articulate– diminishes the odds of some future terrorist act?

Eric Holder

We are at war!

These people attacked us as part of the ongoing war with terrorists. No one should “rest easy” because some lawyer is going to sleepwalk through a trial that may or may not successfully reach the painfully obvious conclusion that the Christmas Day Bomber is guilty! On the contrary, it makes me very uneasy that he is in the civilian court system at this point in time at all, because every moment spent reading this man his rights is a moment that could have been spent gathering intelligence from a terrorist. His punishment will come in due time. In the meanwhile, we have to extract as much information from his as we can in order to defend ourselves.

November 05, 2010

Apparently, according to the most recent unemployment figures released by the U.S. Department of Labor, despite the fact that the overall unemployment rate remained at 9.6%, about 159,000 private sector jobs were created during the month of October.

The worst thing you can do is to attribute these jobs to anything President Obama is doing. I challenge you to draw a straight line between any of the President's policies and the creation of a single private sector job. These jobs were created DESPITE what Washington is doing. That's what the private sector does, day in and day out, while Congress fights over which wasteful spending project they will fund next.

Can you imagine how great the news would be if not for the oppressive policies of this White House? If tax hikes weren't looming? If health care reform wasn't threatening? If the White House was occupied by someone who understood and supported the magic that happens inside of the average American business every day?

I can. So let's give credit where credit is due -- to private industry, the local gift shop, insurance agent, or pet groomer. And let none of the credit go to the White House on this one.

October 26, 2010

Fannie Mae and Freddie Mac are at the very core of the most recent financial crisis. Without them, the crisis would not have occurred. Fannie Mae and Freddie Mac get between lenders and borrowers and distort the pricing of their transactions. Fannie Mae and Freddie Mac have, as their mandate, social engineering, not arms-length business negotiations conducted for mutual benefit. They have no business worming their way around our economy.

Fannie Mae and Freddie Mac continue to operate because they make politicians better off, not business people or consumers. Someone is getting their pockets lined. I believe that when the real operations of Fannie Mae and Freddie Mac see the light of day, that you will be stunned by the sheer magnitude of the fraud, corruption, and destruction of wealth.

October 22, 2010

The next time you hear about the deficit, the level of government spending, or a new bailout program, please consider the following. We have it backwards: government spending should never justify collecting taxes. Instead, collecting taxes should first be fully justified by the specific government spending. If we cannot justify the government spending as absolutely necessary for the public good, then the dollar of taxes should never be collected.

Instead, today, taxes are routinely collected and THEN the politicians fight over how the taxes are going to be spent. In fact, government spends future tax revenues!

We have it backwards. The press has it backwards. The pundits have it backwards. Congress has it backwards. The White House has it backwards. The only debate out there seems to be about WHAT we spend the tax revenues on, instead of whether the tax revenues should be collected in the first place.

I think if we put government spending to such a test, we would decide against most of it, and our taxes would fall to a level that supported a vibrant economy with low unemployment and stable prices.

August 07, 2010

I don't know Ms. Romer personally but I certainly know her work both in and out of the White House. I can only hope that the inconsistency between her work as a truth-seeking academic and as an Obama apologist finally got to her and is, at least in part, one of the reasons she resigned as chair of the White House Council of Economic Advisers.

It will be very interesting to see how her writings progress from here.

May 25, 2010

Does anyone else see how perverted this story is? A company which is 60% owned by the U.S. Treasury, in other words, 60% owned by taxpayers -- not voluntary shareholders, but TAXPAYERS, has hired a private investment banking company to take the company public. That is, to be sold to public stockholders. For a profit. Which is going to be distributed to whom? The government. Who took the company over by edict, essentially by force, ignoring lawfully binding financial contracts in the process. Oh, yes, technically G.M. went through a "banktuptcy," but when one of the two involved parties is the federal government -- the one who makes up the rules of the game -- then it isn't a game anymore. It's "do it, or else!"

GM Headquarters

Absolutely unbelievable. This IPO should not be happening. The bailout should not have happened. None of this should have happened. If the company cannot generate a profit in the marketplace, then it should go bankrupt and its resources freed up to be used where they are most valued by the marketplace.

May 20, 2010

Thugs from the Service Employees International Union (SEIU) and Chicago's National Political Action trespassed on a Bank of America Executive's front lawn in a so-called "protest" over mortgage defaults.

SEIU Protests on private citizen's front lawn

This same group went after AIG executives in March of last year (see video). I commented on local television and to anyone who would listen then how misdirected their anger was, and I repeat that sentiment now.

Where is the President's outrage at these mob tactics against a private U.S. citizen? I can only assume his silence is tacit approval. The recently-resigned President of SEIU, Andy Stern, is reportedly Obama's most frequent visitor at the White House, after all. And Obama has made it abundantly clear that he has no respect for private industry and free enterprise.

May 13, 2010

I'm sure you've heard about the steady rise in gold prices over the last several months. You may have also seen the advertisements from gold investment companies pushing the purchase of gold, or heard predictions about even higher gold prices as world currencies struggle. And just yesterday, the world's first "Gold ATM" machine was unveiled in Abu Dhabi (Gold ATM Machine, Financial Times).

Gold dispensing machine in Abu Dhabi

We have to take a step back and ask ourselves about the true underlying value of gold. Why is it valuable? Because people demand it, and there is a relatively limited world supply. Why do people demand gold? It's not like gold will sustain you: you can't eat or drink it, nor does it have utility in and of itself. No, the reason gold has value is because it can be exchanged for money which, in turn, can be exchanged for goods or services. So the value of gold is derived from the very same place as is the value of money: access to underlying goods and services.

The actual value of gold, however, is entirely dependent on other people's demand for gold, given limited supply, much like fine art. Unlike money, you cannot actually use gold for transactions: have you tried to use a bar of gold at your local restaurant or car dealer, for example? Think about it: if for some reason gold fell out of favor -- let's say someone discovered it was toxic -- then gold would no longer be desired as an indirect means of exchange -- having to first be exchanged for currency -- and its price would drop to nothing, quite independently of the value of money itself.

The value of money it also dependent on its demand, which in turn depends on the acceptability of the currency on the world stage as a unit of exchange. Dollars are accepted as currency and retain their value as long as the underlying real U.S. economy continues to be productive, and as long as the world supply of dollars does not outstrip the world demand for dollars.

Dollars are suffering at the moment for two primary reasons: the attack on private industry by Obama's policies, and the excessive world supply of dollars. Both of these factors drive down the value of a dollar, and drive up the number of dollars that a bar of gold commands.

May 10, 2010

Just to try to help put stock market swings into perspective, consider this:

the 347.8 point fall in the Dow Jones Industrial Average last week, from 10868.12 at the start of the trading day on Thursday, May 6, 2010 to 10520.32 at the close of trading, can be COMPLETELY explained by an increase in the perceived cost of capital from 12% to 12.23%.

do the math. Using the constant dividend growth model, a very simplified model of the market value of equity, or Market Value = Current Dividend/(cost of equity capital - dividend growth rate), and assuming a long-term average cost of U.S. equity capital of 12% and average growth rate of 5%, we find that the opening level of 10868.12 = 760.77/(.12 -.05), and the closing level of 10520.32= 760.77/(.1223 -.05).

I think it is entirely possible that the chaos in Greece and surrounding nations, and the interconnections between worldwide supplies of liquidity and financial capital, that an increase in the perceived risk and uncertainty of the returns to equity from 12% per year to 12.23% per year makes perfect sense.

The market's are working. Market participants, from the individual investor using on-line trading at 2:00 in the morning from their living room to the most sophisticated computerized large-scale institutional trader, understands that a borrower's ability to pay back its investors depends on the real productivity and growth of private industry, whether the borrower is a company or a country.

May 09, 2010

Derivative securities are not inherently evil, though the media, and certain guest authors on this blog, would have you think otherwise. It seems that any type of investment that does not directly involve commodities is an easy target these days.

But derivatives are just another type of investment, those whose value is derived from some underlying security or asset or event. Insurance is a type of derivative investment, as a matter of fact. If the bad event happens (a car accident, flood, or fire, for example), then a claim is made against the policy. If not, the policy expires. The value of the policy is derived from the insured asset or event.

If derivatives are bad, then so too is insurance. If derivatives are bad, then so too are leases with the option to own. If derivatives are bad, then so too is the equity in any type of company, small or large, private or public, including those that produce real products and commodities, for stock is nothing more than an option to buy the underlying assets of the company for the price of the face value of its debt. If derivatives are bad, then so too are convertible securities and most every other type of financial innovation we’ve witnessed in the last 30 years, and for decades to come.

April 03, 2010

I've taken the liberty of reprinting in its entirety a recent piece by Karl Denninger of Market Ticker on the state of U.S. incomes. This piece helps underscore the inescapable reality that private industry drives our economy.

Personal income increased $1.2 billion, or less than 0.1 percent, and disposable personal income (DPI) increased $1.6 billion, or less than 0.1 percent, in February, according to the Bureau of Economic Analysis. Personal consumption expenditures (PCE) increased $34.7 billion, or 0.3 percent.

Oh boy, now the $1.3 trillion in additional deficit spending is no longer contributing to personal income! That's not so positive - indeed, it's not positive at all.

Proprietors' income decreased $6.1 billion in February, the same decrease as in January. Farm proprietors' income decreased $7.1 billion, the same decrease as in January. Nonfarm proprietors' income increased $1.0 billion, the same increase as in January.

Very little change in proprietor's income ex farming, but farmer income is down significantly.

Rental income of persons increased $2.2 billion in February, compared with an increase of $1.9 billion in January. Personal income receipts on assets (personal interest income plus personal dividend income) decreased $16.5 billion, the same decrease as in January.

Rents up a bit, but dividends are down huge, continuing a trend. This is not positive at all, and implies that assets are being sold to continue lifestyle choices. This leads to a question that has begun to gnaw at me: Have we begun to cross into where boomers start pulling funds out of asset classes to live on?

Personal current transfer receipts increased $16.6 billion in February, compared with an increase of $29.8 billion in January. The January change reflected the Making Work Pay Credit provision of the American Recovery and Reinvestment Act of 2009, which boosted January receipts by $19.8 billion. The Act provides for a refundable tax credit of up to $400 for working individuals and up to $800 for married taxpayers. When an individual’s tax credit exceeds the taxes owed, the refundable tax credit payment is classified as “other” government social benefits to persons.

Government to the rescue! $45 billion worth in the last two months, to be specific. That's a direct $270 billion in handouts, or 2% of GDP - and that's only the direct handouts! So subtract that off GDP and..... (oh, and don't forget the rest of the $1.3 trillion too.)

Nothing to see here folks, as in "no evidence of sustainability in the recovery." We have a government that continues to "prime the pump" but there's no water at the bottom of the well to generate self-sustaining economic growth.

The official unemployment rate of the U.S. economy remains at 9.7%, and the underemployment rate increased to 16.9%. These numbers represent a real tragedy for many Americans.

While the White House tries to celebrate the creation of 162,000 new jobs last month, at least 48,000 of these are government jobs, specifically temporary census workers, who are doing unproductive work and are being paid with taxes collected from the rest of the private economy.

Employment also increased in temporary help services and healthcare, but continued to decline in financial activities and in information, which is interesting given the recent comments by President Obama that the government takeover of the student loan program "took $68 billion that would have gone to banks and financial institutions." That's a lot of private industry jobs, Mr. President.

Seems like there is more concrete evidence that, rather than creating jobs, the President's policies are costing the economy jobs.

April 01, 2010

This is part 3 of a multipart series on the factors that drive U.S. and foreign bond prices and yields.

The yield on a bond is made up of several components. Some think of the return on a bond as the sum of the risk-free rate of interest (how impatient we are to get our money back, or how much we need to be compensated to delay consumption) and a risk premium (the additional return we require to compensate us for the risk of default, the risk the bond will be called, the risk of inflation reducing the purchase power of the repaid dollars, and many other sources of risk as outlined in the most recent article in this series).

Another useful way of thinking of the return on a bond is as the sum of the real rate of interest and the expected rate of inflation. But what is the real rate of interest? We never actually observe that rate, unless of course the inflation rate is zero and then the real rate is just the nominal rate set in the market.

It is useful, however, to think about what drives the ability of a company to generate a real rate of return to lenders, for this is essence of capitalism and risk-taking and creating economic value and growth.

Bond traders

A firm’s asset cash flows support the real returns to its lenders – all kinds of lenders (debt, equity, hybrid, and derivative security holders). A firm will want to borrow more, and is willing to pay a higher interest rate for those funds, the more profitable are the projects they want to undertake, or the greater the number of profitable projects. Profitability, in turn, is determined by the relationship between demand and supply: how much does society value a good or service, and how many resources does the business use in producing the good or service. As the marginal productivity or efficiency of a business goes up, it can afford to profitably fund more projects. So the core driver of the real return on bonds is the strength of the underlying economic activity of the private economy.

Or, when viewed from the investor’s side, note that an investor will purchase a bond, or lend money to a company, if they expect to earn a return sufficient to compensate them, first, for delaying consumption and, second, for bearing the various sources of risk or uncertainty associated with the bond’s cash flows or return.

Bond’s in a weak or faltering economy will generate a lower return to lenders than bonds in a strong economy, absent inflation or any other material changes in the purchasing power of the currency. Weak demand for goods and services means weak demand for financial capital which means low rates of return on financial capital.

The policies of the government can increase the borrowing costs of private industry. Fiscal policy that increases taxes reduces the profitability of projects and undermines the ability of companies to pay coupons and repay principal. Monetary policy that increases the money supply may lead to inflation, which also increases the cost of borrowing and reduces economic activity.

Lastly, and of the greatest concern of late, is the level of borrowing by the U.S. government. Debt levels are at record highs, with no relief in sight. The AAA rating of U.S. debt is reportedly in jeopardy (Chicago Tribune editorial). Both existing and new lenders worry about the ability of the U.S. government to repay. Yes, the can simply roll over existing debt by raising taxes or creating money to retire old debt and replace it with new, but the interest rate required by new lenders goes up as the ability of the private economy to sustain tax revenues falls and the risk of inflation rises (Moody's explains U.S. bond rating).

Both factors are in play now: an anemic economy with little hope that this administration will undertake policies that support business, and a ballooning money supply and weak dollar that undermine the purchasing power of the returns to lenders. The returns to U.S. debt may still be healthy relative to those one can earn in other countries, but the spread is shrinking. The private economy remains fundamentally strong, thanks to the work ethic of the American people and the profit motive of the capitalistic system, but the policies of the U.S. government are straining those resources.

March 25, 2010

Ben Bernanke, the Chairman of the U.S. Federal Reserve, announced that the Fed was likely to begin to sell some of the $1 trillion in mortgages, the so-called “toxic assets,” that it purchased over the last fifteen months to help stave off a total credit market meltdown. Those purchases essentially doubled the U.S. money supply, igniting fears of potential inflation should the underlying real economy recover before the money supply could be drawn back down. See earlier post.

Well, the process of tightening the money supply may be just around the corner. And increases in interest rates and the cost of everything purchased on credit – homes, cars, durable goods, and business capital expenditures – are not far behind. Increases in interest rates dampen economic activity, an unfortunate development given the current lethargic state of the U.S. economy. But it has to be done sometime – we cannot sustain such a huge increase in the money supply without paying an even higher price in terms of inflation and a weak dollar.

It will be interesting to see who buys the toxic assets and how much they will pay. Regardless, the sale will reduce the money supply which, if done in a slow, orderly manner, is a good thing for the economy. Getting the Fed out of the business of buying and selling private market securities will be an even better thing for the U.S. economy. Now more than ever we need a monetary authority that is focused on the best policies for our economy, not those that help Fannie Mae, the White House, or the Treasury Secretary save face.

March 10, 2010

This is part 2 of a multipart series on the factors that drive U.S. and foreign bond prices and yields.

Recall that a bond’s price is the present value of its coupons (if any) and face value (or principal or par value). Let’s keep things simple for now and consider a zero-coupon or “discount” bond.

One thing of interest to note first: As we move forward in time from the issue date toward the maturity date, and the number of periods between now and the maturity date falls, the price of a discount bond rises toward the face value of the bond, even with no changes in the interest rate. At maturity, the price of the bond equals the face value. Only unexpected changes in the effective return on a bond can change the natural upward progression of its price toward face value between the issue and maturity dates.

This example makes clear that the (annual) yield on a bond, simply put, is driven by the difference between the price paid for the bond and the cash flows it generates, that is, the difference between “dollars out” today and “dollars in” later.

The “dollars out” are known because we pay a given price for the bond today. The “dollars in,” consisting of coupons (if any) and the face value of the bond, are also “known” in that they are specified in a contract at the time the bond is issued. The realized value of these dollar returns is, however, subject to many different sources of uncertainty or risk. A short list includes:

Interest rate risk: how sensitive the price of the bond is to changes in interest rates over the life of the bond. Interest rate risk is higher for bonds with a longer maturity (more time for the unexpected to happen), a lower coupon (more of the value of the bond is tied up in the principal), and a lower initial yield (a 1 percentage point change in interest rates represents a higher relative change in low yields). Floating-rate bonds have much lower, though not zero, interest rate risk.

Reinvestment rate risk: Bondholders may reinvest their coupons at the then-prevailing rate of interest. As those market rates of interest change, the return on reinvested coupons becomes less certain. Reinvestment risk is higher the higher the coupons, the more frequently the coupons are paid, and the longer the maturity of the bond.

Bankruptcy Court: Destination for issuers in default

Credit or default risk: the risk that the issuer will default on the payments of the bond, which reduces the number of “dollars in” relative to price paid, lowering the earned yield on the bond. Credit risk is frequently measured as the credit spread over like Treasuries, which are assumed to have zero credit risk. Credit risk includes downgrade risk, where a credit rating agency lowers the rating on an issuer as their ability to repay the debt is brought into question.

Call risk: the risk that a callable bond will be called by the issuer. Since a bond is typically called only when it’s in the best interest of the issuer, the call feature is systematically harmful to the bondholder. Prepayment risk reverses these risks: prepayment is good for the bondholder, and bad for the issuer.

Exchange rate risk (that the value of the repaid currency will be lower), inflation risk (that the value of the repaid dollar will be lower), and event risk (natural disasters, corporate restructurings, regulatory changes, sovereign or political changes) round out the list of broad types of risks that drive bond yields.

Next time: why the types and level of risks are so difficult to measure and predict.

March 09, 2010

Finally, we hear from the Federal Reserve about how they plan to unwind the billions of dollars of toxic assets they purchased over the last 18 months or so without creating further distortions in the U.S. and world financial markets (Fed lays out exit detail). This after the Fed barely acknowledged one of the most dramatic runups in the money supply in U.S. history.

The announcement came in a speech by Brian P. Sack (pictured at left), the executive Vice President of the Markets Group at the Fed. I am impressed by this guy. He seems to know what he's talking about and seems to understand how markets and fed policy interact.

In earlier posts (http://www.sherryjarrell.com/2009/06/t.html) I wondered aloud how the Fed might accomplish this tricky task. It is a very delicate balance between reducing the money supply too quickly, which would spike short term rates, and too slowly, which would increase long-term rates due to worries about inflation (which occurs when money growth is higher than the economy's real growth, even if money growth is falling).

The Fed, the article explains, apparently intends to let $200 billion of the estimated $1.25 trillion in new money supply simply "mature" by the end of 2011 without replacing it. This represents largely toxic assets. The Fed might let another $140 billion of Treasuries it purchased during normal open market operations mature at the end of 2011, but they aren't committing to that. So that's about $340/$1,250 or about 35% of the historic increase in money supply that may be vaporized over the next 21 months. What about the rest? It would be nice to know but....

The Fed is doing the right thing by explaining its policy intentions -- ANY of its policy intentions -- to the markets. Markets want, need, and deserve information from our officials, something that has been sorely lacking of late. With information, lenders and borrowers can plan, they can optimize. Without information, guessing, withdrawing from the market, and fear rule the day. Not a good environment for economic recovery.

March 07, 2010

Years ago, in the summer of 1980, I worked as an intern in the Federal Home Loan Bank Board at the Department of Agriculture. I was a senior in college majoring in business and had been accepted to the University of Chicago doctoral program. I didn’t want to take the internship because I wanted to take more courses over the summer to help prepare me for the rigors of grad school, but my college advisor had openly worried that I was far too serious for a young person. He strongly encouraged me to accept the internship and take a break from academics before I immersed myself in graduate school, and buried myself once again in all things economics!

The U.S. Department of Agriculture was a major lender

I agreed, but only after I had arranged to take 6 credits of independent study in D.C. I chose to examine the Negative Income Tax program, one of the largest social experiments in U.S. history. More on that at another time. Today, I want to talk about what I learned from being an employee of the U.S. federal government.

The first thing I learned was that the “problem” with government work is not the people; well, not all the people. There was one man who spent his entire day going back and forth to feed quarters to the parking meter rather than pay for public transportation or do his work. He represented the worst in government employees. Most all of the others I met were hard-working and honest people, trying to do a good job and make a difference.

President George H. W. Bush

No, I learned that the real problem was with the way the "work" is done in government. I worked for the Federal Home Loan Bank Board (FHLBB) that summer, which was one of the largest lenders in the world. The FHLBB was responsible for small business, rural, agricultural, and economic development lending. My job was to review loan applications from community groups, fairs, farmers’ markets, and various municipal organizations to make sure that they were complete. We did not analyze the applicants for creditworthiness. Instead, if the application was correct and complete, and satisfied the application process, it was approved. The FHLBB, which was publicly trashed by the first President Bush as being largely responsible for the savings and loan crisis, was abolished and replaced by the Office of Thrift Supervision (OTS) under the Department of the Treasury in 1989. The OTS eventually expanded its oversight to companies that were not banks, including Washington Mutual, American International Group (AIG), and IndyMac, all implicated in the current U.S. financial crisis.

AIG

Little did I know back in 1980 that I was witnessing, from the inside, a government lending process that would lead to the most significant financial crisis since the Great Depression. Looking back, the outcome was perfectly predictable: when politics replaces profits as the motivation of the lender, it should be no surprise that losses result.

March 04, 2010

I honestly cannot understand how President Obama can look the American people in the eye and tell them that Health Care reform will be paid for, in part, by finding savings and reducing fraud in Medicare over the next several years.

President Obama on Health Care Reform

If it is possible to operate Medicare more efficiently, why have we not done it already? Why must doing it right wait for new programs and new legislation? Why doesn't Congress first prove to the American people that it can operate a program efficiently and then come back and ask for more?

Because it can't, that's why not. The plain and simple truth is that it cannot do so now, and will not do so in the future. So why are we letting our elected officials get away with such a charade?

Senator Dennis Kucinich (Democrat – Ohio) is on the media circuit promoting his rather novel idea on how to “create” jobs for younger people who are trying to enter the work force but can’t because of the recession.

Kucinich, who ran for the Democratic nomination for President in both 2004 and 2008, estimates that about 25% of those eligible to retire at age 62, or about 1 million people, would choose to take early retirement under his plan. He claims that this is a conservative estimate, since about 70% of those who can retire at 62 do so now.

These early retirees would, of course, collect social security earlier, after having worked fewer years and contributed less to Social Security. And then we’d have to assume that these workers would be replaced by the younger people now looking. And that they would generate the same tax revenues for the government that the early retirees did.

What a plan! Lock in higher costs, with no guarantee of any benefits. This is the kind of logic that put the U.S. into this pickle in the first place.

How does Senator Kucinich propose to pay for this plan? Why, with government funds, of course! Specifically, with the “extra” unspent stimulus and TARP funds. This, despite the fact that he has spoken repeatedly about voting against the TARP funds because he opposes government interference in the private economy. But, hey, he goes on to say, “Since the money is lying around anyway, let’s use it!” You’d think tax revenues fall out of the sky!

I do not know which is worse, the hypocrisy or the ignorance. What folly! This man has absolutely no business talking about how to create jobs when he has no idea how the economy actually works.

Here’s an idea that is guaranteed to help the economy recover. Why doesn’t Senator Kucinich take voluntary early retirement!?

March 02, 2010

The U.S. GDP grew at an annual rate of 5.9% in the last quarter of 2009 which may look good at first glance, but when we dig a little deeper, we find some concerns about the implications for sustainable growth. A large fraction of this reported growth came from businesses selling off accumulated inventories, which has more to say about past production than current. Exports were also a significant source of fourth quarter growth, driven in large part by a weak dollar. Of course, a weak dollar is a very mixed blessing for the economy, and is hardly a sign of a strong or recovering economy.

Real residential fixed investment increased 5.0 percent, helped along by the extension of the home purchase tax credits from the federal government.

Real nonresidential fixed investment increased 6.5 percent. This figure nets out nonresidential structures, which decreased at a troubling rate of 13.9 percent, and equipment and software, which increased 18.2 percent. Investment in equipment and software consists of capital account purchases of new machinery, equipment, furniture, vehicles, and computer software; dealers’ margins on sales of used equipment; and net purchases of used equipment from government agencies, persons, and the rest of the world. Own-account production of computer software is also included, which is production performed by a businesses or government for its own use.

Again, the underlying figures show that those variables most associated with building a sustainable productive capital base for the economy – nonresidential fixed investment –are declining at an alarming rate. This, combined with a 9.7% unemployment rate and the specter of rising debt levels, energy prices, and taxes, paints a picture of a slow to non-existent recovery to a robust economy any time in the next year.

February 26, 2010

What has become very clear to me, after watching the U.S. Health Care Summit between Democrats and Republicans as objectively as possible, is that the President's goal was not to craft a thoughtful approach to shoring up and improving the U.S. health care system.

Pres. Obama making one of many points at Healthcare Summit

No, the reason for the President and the Democratic leadership to convene the so-called summit was to grandstand; to make a show; to create a photo opportunity; and, most importantly, to try to garner enough support from the Democrats in Congress to ram through the Reconciliation option on the behemoth, disastrous 2000-plus page version of the bill, filled with incomprehensible, internally conflicting doublespeak.

A sad day for American politics. A very sad day for American citizens. We deserve better.

February 25, 2010

I’ve been asked many times over the years for advice on investing. “What is the market going to do?” “Should I be invested in stocks or bonds?” And, especially in the last few weeks, “Should I hold U.S. or foreign government bonds?”

A U.S. treasury bill

Those are some good questions! The answers are not as "good." The factors that drive the yields on treasury bills and bonds are complex and, despite Ben Bernanke’s pronouncements to the contrary, less well understood than stock returns. And, although I don’t have a crystal ball, I can at least frame an answer to these questions here. I will come back to expand on this topic over time, as markets, economies, and world events evolve.

The return on both bonds and stocks is measured as the percent change between the market price today, and the cash flows received later. The cash flows of a bond, namely coupon payments and principal, are specified in a contract; if they are not paid, the issuer is in default, and the bondholder has the right to take them to court. The cash flows on stock, dividends and capital gains, are residual; they are discretionary, and are paid out only after debt payments and other obligations are paid. For this reason, the returns on bonds are considered to be less risky than those on stocks, and as a result the nominal yields on bonds tend to be lower than those of stocks.

There is an important distinction between the nature of the returns on bonds and those on stocks. With bonds, the future cash flows are known: the bond’s yield is determined simultaneously with the bond’s price. Once a bond is issued, only changes in interest rates (yield, risk) drive unexpected changes in its price. Stock prices, on the other hand, fluctuate as either risk or residual cash flows change. As a result, changes in a bond’s price, hypothetically at least, are a much cleaner indicator of the market’s expectations of future market rates of interest than movements in a stock’s price.

The information about future interest rates that is revealed by changes in the bond’s price is distorted somewhat by the fact that bonds are less frequently traded than stocks, so the price data on bonds is less comprehensive and complete. In addition, the reported price data that form the basis of bond yield models often diverge from actual market-clearing prices, so that bond pricing models may not describe actual market behavior. Lastly, there is such a tremendous volume of economic and policy information, some of it conflicting, that is crammed into this one variable, the bond price, that it is very difficult to isolate what bond price's say about any one factor, like the term structure of interest rates.

February 20, 2010

Does the Fed Funds Rate, the rate charged by the Federal Reserve to make short-term loans to banks, directly influence the interest rate consumers and businesses pay on credit cards, mortgages, and consumer and business loans? If you took the word of the average business news commentator, you would think not. But the answer, of course, is yes.

One way to view the market rate of interest, although certainly not the only correct or useful way, is to think of it as a base rate that represents the risk-free rate, a rate that compensates the population for its impatience to consume the goods it would have consumed had it not lent the funds out in the first place. This risk-free rate is also influenced by the efficiency and functioning of the capital markets that bring borrowers and lenders together.

A risk premium is then added to this base rate of risk-free interest, one that varies depending on the degree of uncertainty of the lender getting repaid. The risk of default, the risk of prepayment, the risk of political uprising, exchange rate risk, and many other sources of uncertainty -- including the risk of inflation -- raise the level of the risk premium commanded by lenders in the market. As an example, over the last 100 years or so, the average annual risk-free rate in the U.S. has been about 4%, and the average annual risk premium for equity securities has been about 8%, bringing the average annual observed interest rate or rate of return to about 12% on these securities.

So what happens to the interest rate charged to consumers and businesses when the Fed raises the fed funds rate? Basically, the level of the risk-free rate in the economy rises and, as debt contracts expire or new lending takes place, this higher base rate gets factored into the market rate of interest charged.

Overall, the demand for loanable funds falls, the aggregate demand curve for the economy falls, and equilibrium output and employment fall, RELATIVE to where they would have been without the rate increase. The bright side is that a reduction in the money supply that accompanies an increase in the fed funds rate is absolutely essential to curtailing inflation, which drives the risk premium, and represents a much greater cost to the economy.

February 18, 2010

What does it mean when the Fed raises the interest rate? It helps to first understand how the Fed raises the rate, which may surprise some people. The Fed does not "set" the interest rate as it might, for example, by declaration or edict or by fixing prices. No, it targets a higher interest rate by contracting the money supply until that money supply intersects the market demand for money at a higher market-clearing rate of interest.

How
does the Fed reduce the money supply? Typically by conducting open market
operations, which is the purchase or sale of government securities by the Fed.
To raise the money supply, it purchases new government securities, paying
for them by creating--out of thin air--reserves for the commercial banking
system. To reduce the money supply, it sells securities which shrinks the
amount of deposits in circulation in the economy. In other words, it reduces
the liquidity or amount of credit in the system. This is equivalent to
reducing aggregate demand for the goods and services in the economy. (Yes, you
heard right; an increase in the money supply increases
the aggregate demandfor goods and
services by businesses and consumers.)

Raising
interest rates is a contractionary policy decision. It is designed to
slow down the economy, reducing output and employment, and raising the
equilibrium prices of goods and services in the economy. Why would the
Fed choose to contract an already anemic economy? To head off inflation,
which has its own set of insidious costs and distortions that significantly
hurt the economy.

The
Fed has always had to tread a very fine line between increasing the money
supply enough in the short run to minimize the depth and length of a recession,
but not increasing the money supply so much that it creates inflation in the
longer run. Excessive money growth is what causes inflation. And
over the last two years, the U.S. has witnessed a record-shattering increase in
the money supply as policymakers struggled to deal with an unprecedented financial
crisis.

I
have been saying for months that this behemoth money supply would
inevitably lead to significant inflation unless steps were taken to shrink it.
I believe the Fed has now begun to take those steps.

What this means in practical terms is that the cost of
borrowing by the U.S. government will rise, which will increase spending via
more borrowing or higher taxes or more money creation to pay for the higher
interest costs. Sound like a vicious
cycle to you?

Has anyone noticed the absolute irony of the world capital market
having a seat at the table that assesses the viability of Obama’s policies?
Obama has spent the last year denigrating free markets, and
has laid the blame for the credit crisis squarely at the feet of those "greedy
capitalists." Now he has to deal with a rating agency, which plays a pivotal role
in the functioning of those very capital markets, evaluating the
creditworthiness of the policies of the White House and its Budget Director, Peter Orszag.

I am an economist, Mr. President, and I know, based either on simple first principles of economics, or on a more rigorous controlled study of labor markets in each major sector of the economy, that the unemployment rate would have been much lower today had the stimulus program never occurred.

You are either woefully unaware of the facts, Mr. President, or are purposefully distorting the facts. Neither is good. When are you going to realize that just because you say something does not make it so. The world does not contort itself to support your version of the truth.

January 27, 2010

President Obama's proposal to freeze parts of federal government spending over the next three years is a lot like a smoker buying a truckload of cigarettes today, then promising to "freeze spending" on cigarettes tomorrow. He can keep smoking for years to come without spending another dime.

These massive asset purchases, orchestrated by Timothy Geithner, the current Treasury Secretary and former New York Fed official, ballooned the Fed's balance sheet from $800 billion in primarily government bonds to $2.3 trillion in toxic assets.

Now the New York Fed is overseeing the assets brought into the Fed by the Treasury Secretary as he moved from the New York Fed to the Treasury. All while the Treasury functions are supposed to be isolated from the Federal Reserve's role in its implementation of monetary policy.

January 21, 2010

Keep in mind, even as the number of first-time claims for unemployment insurance rose again this week, that the 10% U.S. unemployment figure understates the actual number of unemployed. Even the 17% underemployment figure, which includes those who are either unemployed or who are working part-time but would like to work full-time, fails to include many of those who have lost their jobs but, because they fail to qualify for unemployment, are not being tracked. I know several such people personally; one has been unemployed for over a year.

My point? Structural unemployment is a serious economic issue. But the solution is not to funnel more unemployment benefits to the unemployed. The best thing the government can do is to reduce the barriers it has erected to a vibrant economy, including oppressive taxes, fees, paperwork, bureaucracy, and regulations that repress business productivity and raise prices. By reducing these explicit and implicit costs, there is absolutely no doubt that the private economy will be able to employ more workers as it produces more output at lower prices.

The best thing we can do as private citizens and neighbors is to treat each other right. Keep the economy moving. Put in a good day's work. Volunteer or learn a new skill if you can't find a job. Fill a need. Buy smart. And, finally, elect business-friendly local and national politicians. It matters.

January 20, 2010

This is part 3 of a 3 part post on the saga of the ill-fated 1998 merger between Daimler and Chrysler.

The Daimler-Chrysler merger was troubled from the beginning. Investors sued over whether the transaction was a 'merger of equals' or a Daimler-Benz takeover of Chrysler. A class action lawsuit was settled in August 2003 for $300 million. A lawsuit by activist investor Kirk Kerkorian was dismissed in April 2005, but claimed the job of the merger’s architect, Chairman Jürgen E. Schrempp, who resigned in response to the fall of the merged company's share price. The merger was also the subject of a book Taken for a Ride: How Daimler-Benz Drove Off With Chrysler, (2000) by Bill Vlasic and Bradley A. Stertz.

It is questionable whether the merger ever delivered promised synergies or ever successfully integrated the two businesses. As late as 2002, DaimlerChrysler appeared to run as two still-independent companies. In 2006, Chrysler reported losses of $1.5 billion. In 2007, it announced plans to lay off 13,000 employees, close a major assembly plant, and reduce production at other plants in order to try to restore profitability.

It was all for naught. In May of 2007, DaimlerChrysler announced that it would sell 80.1% of Chrysler to Cerberus Capital Management of New York, a private equity firm specializing in troubled companies. Daimler continued to hold a 19.9% stake. Daimler paid Cerberus $650 million to take Chrysler and associated liabilities off its hands, an amazing development given the $36 billion Daimler paid to initially acquire Chrysler. Of the $7.4 billion purchase price, Cerberus invested $5 billion in Chrysler Holdings and $1.05 billion in Chrysler’s financial unit. The de-merged Daimler AG received $1.35 billion directly from Cerberus but invested $2 billion in Chrysler LLC itself.

On April 27, 2009, Daimler AG agreed to give up its remaining 19.9% stake in Chrysler LLC to Cerberus and pay as much as $600 million into the automaker's pension fund. On April 30, 2009, Chrysler LLC filed for Chapter 11 bankruptcy protection and announced a plan for a partnership with Italian automaker Fiat. On June 1, Chrysler LLC stated they were selling some assets and operations to the newly formed company Chrysler Group LLC, with Fiat retaining a 20% stake in the new company.

On June 10, 2009, the sale of most of Chrysler assets to "New Chrysler," formally known as Chrysler Group LLC, was completed. The federal government financed the deal with $6.6 billion in financing, paid to the "Old Chrysler.” The transfer does not include eight manufacturing locations, nor many parcels of real estate, nor equipment leases. Contracts with the 789 U.S. auto dealerships who are being dropped were not transferred. Not a hint of the disastrous Daimler-Chrysler merger remains.

January 19, 2010

Yesterday, I posted part 1 of 3 parts on the saga of the 1998 Daimler purchase of Chrysler in which I set up the question: would the Daimler Chrysler merger, with its internationally traded share and U.S. disclosure rules, be enough to offset the secrecy of the German corporate governance standards at the time of the merger? In today's post, I provide the answer:

When DaimlerChrysler (DCX) incorporated it adopted German corporate governance standards.U.S.
institutional ownership in Chrysler was largely replaced by European banks that
not only directly monitor the working capital financing of DCX but also may sit
on its Management and Supervisory Boards.Such superior access and corporate control created distinct advantages
for large German institutional owners relative to minority owners; foreign
shareholders in the U.S.
found themselves among this minority group.These advantages included the ability to:
expropriate the private benefits of control from minority shareholders; share
these benefits with management, effectively creating a collusion, and; profit
from trading DCX shares with superior information.As a result, minority owners priced their
shares less aggressively – i.e., the bid-ask spread widened -- to minimize
their losses from transacting with controlling shareholders.As their spread increased, U.S. minority shareholders’ trading costs rose
and U.S. trading volume fell
as it migrated to Germany,
the relatively cheaper trading venue.

The
merger between Chrysler and Daimler and consequent changes in corporate
governance create an ideal clinical study for isolating our hypothesis about the
failure of the enhanced disclosure requirements to effectively compensate for
lax corporate governance standards in protecting minority shareholders.To test this
hypothesis, we explored changes in the bid-ask spread that are associated with
the change in corporate governance and the control over the flow of information
about the Chrysler assets.We
look “inside” the trading mechanism that creates the observed transacted stock
price, namely the bid-ask spread, to generate evidence on shifts in the quality
and quantity of information available to minority versus controlling
shareholders.The bid-ask spread should
grow as minority shareholders learn that traders on the other side of the
spread possess superior information about the company, information which is linked
to their majority control of the firm and its senior management compensation,
asset disposition, and financing and risk-taking strategies.

We found that the
decision to merge and become a German stock corporation significantly weakened
the protection of minority shareholders, particularly
prior owners of Chrysler assets, and led to their
expropriation by controlling shareholders and principal creditors of the consolidated
firm. The
answer lies in the lack of protection afforded minority shareholders by the German corporate governance structure of the newly combined DCX entity.

January 18, 2010

In a paper co-authored with Rick Harris, Tom McInish and Bob Wood, we explored the Daimler-Chrysler merger of 1998 to examine the interplay between disclosure rules in the U.S. and corporate governance standards in Germany. Here is an overview of what we found.

Large shareholders typically control European and Asian industrial giants, leaving minority shareholders less than well protected. In several studies of the legal protection afforded minority shareholders across 27 countries, German shareholder protection ranked among the very worst. In the early 1990s, Daimler-Benz, one of the largest firms in Germany, was no exception. In 1993, with Deutsche Bank owning 24% of the equity, Mercedes AG Holding 25%, and the Emirate of Kuwait 14%, its controlling shareholders decided to cross-list Daimler-Benz on the New York Stock Exchange (NYSE).

All foreign firms that cross-list [list their shares for sale in more than one country] in the U.S. subject themselves to stricter disclosure standards. In addition to listing on a major U.S. stock exchange, Daimler was required to file financial statements with the SEC and report any material non-financial information as well. Cross-listed firms are also followed more closely by U.S. stock analysts and the business press. These legal disclosure requirements and additional scrutiny by the investing community improved both the quantity and quality of information available to all shareholders about Daimler.

By early 1998, the cross-listed Daimler shares were widely held and actively traded worldwide, including significant volume originating in the United States. In September of 1998, Daimler and Chrysler shareholders, majority and minority owners alike, overwhelmingly approved a merger creating DaimlerChrysler AG (DCX) through an exchange of the cross-listed share for the first “global registered share” (GRS). The so-called “merger of equals” was widely expected to realize both operating efficiencies and, via the informational transparency of the GRS, improved access to international capital markets.

January 14, 2010

evidence of this is the lack of new business formation in developed
nations across the globe.Over the last
year, the number of entrepreneurs starting new businesses in the wealthiest of
nations dropped 10% from the 2006-07 level; in the U.S., that number fell by
24%. http://www3.babson.edu/Newsroom/Releases/globalgem2009.cfm

The contaminants in the fuel line are oppressive government
policies that increase the cost of doing business, increase unemployment, and
raise the risks to the current labor force of quitting their jobs to try to
start new businesses.

At a time when government should be encouraging venture
capitalists and the formation of new business, it is instead putting on the
brakes to this source of economic growth in the form of cap and trade, compensation
regulations, fees on banks, and myriad other explicit and implicit new taxes. In 2009,
nearly half of U.S. employment was generated by small businesses; U.S.
companies started through venture capital employed more than 12 million people,
or 11 percent of private sector employment, and generated $2.9 trillion in
revenues, or 21 percent of U.S. GDP.

Fully 100% of economic growth is created in private industry. Government simply redistributes that wealth, destroying some portion of it in the process. Never have we needed non-interventionist government policies more.

January 12, 2010

The Federal Reserve, it has been reported, earned record
"profits" of over $46 billion in the year ending December 31, 2009.
The previous record profit was $34.6 billion in 2007. The Fed earned
$31.7 billion in 2008. The financial crisis has apparently been very good for
the Fed, although, as a non-profit entity, all its profits are turned over to
the Treasury. As an aside, I wonder what the Treasury plans to do with
its windfall?Reduce taxes? Hmmm.

Be careful, however. "Profits" are a bit of a
misnomer for the Fed's activities, because they pay for what they do by
creating money out of thin air. To buy a financial instrument such a
treasury bill or mortgage-backed security, which is added to the left-hand-side
of their balance sheet as an asset valued at cost, they create (and I do mean
"create," in the true sense of the word) an equivalent amount of
deposits on the right-hand-side of their balance sheet. It does not "cost" them resources as it would you, or me, or a business. The "expense" is deducts from revenues to arrive at this period's profits consist mainly of employee salaries.

So if the Fed purchased a bunch of assets with reserves that they
created, where do the "profits" come from? Keep in mind, there
are two major drivers of profits. One is efficiency, or doing more with
your resources. The second is pricing power, being able to charge an
above-competitive price for a good or service either because you own something
scarce or you make up the rules of the game.

First, two minor sources of income to the Fed are the
interest and fees it charges for operating the financial system, such as check
clearing and interbank electronic payments, and those it charged participants
in the emergency loan programs it undertook to support credit cards and auto
loans.

By far the largest source of revenue to the fed, however, came
from its open market operations and the purchase of toxic assets. The Fed
had about $1.8 trillion in U.S. government debt and mortgage-related securities
on its books by the end of 2009, four times the level in 2008, and the interest
payments it collected on this huge pile of assets generated much of their
(so-called) profits. But interest payments are only one source of returns
on financial assets. The other is "capital gains" or "price
appreciation." If and when the Fed sells these assets, some of them
considered "toxic," there is a real risk that they will incur
significant capital losses. For example, the central bank recorded
a $3.8 billion decline in the value of loans it made in bailing out Bear
Stearns and AIG.

So the Fed’s profits are this period’s interest income minus the
Fed’s minimal operating expenses; the capital base on which it earns income is
basically “free.” And all of these figures focus on one-period accounting
entries, ignoring the huge potential negative stock of value the Fed’s
activities are generating.

Don’t misunderstand. The Fed provides an invaluable service to the
national and world economies, and they generally execute those services very
well. But when they begin to try to act like a business, replacing
existing investment banking with their own activities, and parade around profit
figures as if they meant the same thing as private industry profits, we must step
back and take a moment to understand that Fed profits mean something entirely
different from corporate profits.

January 11, 2010

The latest from Washington on Health Care Reform is the Senate's version which taxes insurance companies on plans valued at over $8,500 for individuals and $23,000 for couples.

President Obama has defended the tax as a way to drive down health costs. "I'm on record as saying that taxing Cadillac plans that don't make people healthier but just take more money out of their pockets because they're paying more for insurance than they need to, that's actually a good idea, and that helps bend the cost curve," the president said in an interview with National Public Radio just before Christmas. "That helps to reduce the cost of health care over the long term. I think that's a smart thing to do." http://www.cbsnews.com/stories/2010/01/07/politics/main6066223.shtml

Supply is an upward-sloping marginal cost curve, and includes the taxes and fees a business must pay to the government. By imposing this tax, the supply curve of insurance companies will shift up and to the left, as shown in the graph, representing a higher cost per unit of insurance coverage. The demand curve slopes down, so when intersected by a more costly supply curve, the final price to consumers rises and the amount of insurance coverage falls. Period. End of story. Indisputable fact. And nothing Obama or the Senate says will change this fact, though they will try.

January 10, 2010

Once a single-payer health care program is enacted into law, the government will assume the right to tell us how to live our lives. Our health will be their responsibility. Government officials will feel empowered to tell us what to eat and drink, what risks to take, whether we can smoke, how much weight we can gain and how much exercise we must get.

If you have any doubt, consider the following statements from the Obama administration over the last year. The clear message is if the government pays for something with tax dollars, it has both a right and a responsibility to tell the recipients of those dollars how to conduct themselves.

"This is America. We
don't disparage wealth. We don't begrudge anybody for achieving success,"
Obama said. "But what gets people upset -- and rightfully so -- are
executives being rewarded for failure. Especially when those rewards are
subsidized by U.S. taxpayers." http://wcbstv.com/national/executive.pay.limits.2.926332.html

President Obama challenged top bankers to explore "every responsible way" to increase lending, saying they were obliged to help after being rescued by taxpayers. He asked them to "take a third and fourth look" at their small-business lending. He also exhorted the executives — both in private and in public — to drop their opposition to an overhaul of the nation'sfinancial industry."If they wish to fight commonsense consumer protections, that's a fight I'm more than willing to have," Obama told reportersin the Diplomatic Reception Room of the executive mansion. http://www.msnbc.msn.com/id/34416646/ns/business-us_business/

Obama said it is "wholly unreasonable to expect that American taxpayers would or should hand this administration or any administration a $700 billion blank check with absolutely no oversight or conditions, when a lack of oversight in Washington and on Wall Street is exactly what got us into this mess." Obama said taxpayers should be treated like investors if they are being asked to underwrite the bailout. http://www.cnn.com/2008/POLITICS/09/23/campaign.wrap/index.html

"What’s really frustrating me right now is that you’ve got
these same banks who benefited from taxpayer assistance who are fighting tooth
and nail with their lobbyists up on Capitol Hill, fighting against financial
regulatory control,"Obama added.

January 09, 2010

This topic may seem to be more about politics than economics, but anything related to health care reform is squarely rooted in the most important of economic issues: the costs of doing business, the size of the government, and the potentially oppressive role of government in private industry.

In this article, we see how the Senate Democrats are going to do whatever it takes to get their version of health care reform through, even if it comes down to essentially stealing votes. Could the timing of this Massachusetts special election, to replace the temporary replacement put in for the late Senator Edward Kennedy, be one of the reasons that the Senate wants to rush this reform through before the President's State of the Union Address, typically set for mid-January, though the White House is curiously reluctant to commit to a date.... ?

January 08, 2010

The U.S. unemployment rate remains at a 26-year high. This is troubling for two reasons. One, the struggle and suffering of the unemployed (and underemployed) and the impact on the world economy.

Two, the mixed signals it gives policymakers. I worry that the White House will think that it needs to do "more" of what it's been doing, and will dismiss any negative comments about its economic policies as a knee-jerk reaction to the unemployment figure when I, in fact, would be saying the same things if the unemployment figures had improved. It would be a harder sell, true, but that doesn't change the facts.

The reason? Because I believe we would be in a better position today, with lower unemployment -- no matter what the current unemployment rate -- and higher growth, had the stimulus program never been initiated. I base this on my understanding of the fundamentals of how the economy works, how businesses create value, and how labor makes itself indispensable to industry.

And none of these areas were helped or improved by the economic policies of this President.

January 05, 2010

As the New Year begins, many writers are looking back on the events of 2009. Many are focused on the impact of the bailout and stimulus programs on the U.S. economy. While some credit those programs with ending the U.S. recession, others worry about the resulting deficit and the ability of the government to sustain this level of spending into the future.

I, for one, believe that the economy would have been better off without the bailouts and the stimulus program. But proving that claim is a difficult task, not just for me, but for anyone trying to address the question.

I have a research project under way that I hope will lead to a better measure of the impact of government spending on GDP, but it will be some time before those results are in. In the meanwhile, I want to help to clarify some economic issues that underlie much of the debate about the stimulus and the deficit.

First of all, the deficit is defined for the fiscal year only. It is a one-period measure. The deficit for 2009, for example, is total 2009 government spending (including interest on debt, which is the cumulated book value of deficits) minus total 2009 government "revenues." Government revenues consist of taxes plus the proceeds from asset sales (http://www.govsales.gov/HTML/INDEX.HTM).

Second, the U.S. deficit is our trading partners' surplus. Our borrowing is their lending. There is nothing inherently wrong or weak about the U.S. running a deficit, or selling Treasury bills or bonds to finance spending.

Typically, the Treasury avoids using the Federal Reserve's balance sheet for its tax collecting and check writing activities, expressly to avoid tainting Monetary Policy with Fiscal Policy, or "monetizing the debt." Of late, however, under Geithner's leadership and Bernake's followership, that distinction may be blurred beyond recognition. The current level of the money supply, given fairly stable reserve requirements and discount window policy, is largely determined by open market operations (OMOs), or the purchase (or sale) of newly issued Treasury bills and bonds with newly created Fed reserves; i.e., the famous "the Fed creates money with the stroke of a pen" or, these days,"with a click on the keyboard."

Pre-Geithner, the Fed created money strictly through OMOs and changes in reserve requirements and discount window activities, with the goal of supporting GDP with the appropriate interest rate target without excessive inflation. Now, it's worrisome how much policy independence the Fed seems to have retained. In a real economy crisis with rampant unemployment, should the Fed "do something?" And what if those actions exacerbate inflation? Now what is our policy priority: lowering unemployment or lowering inflaton?

No easy task here: find just the right level of money supply growth that will find the right level of short term interest rates without over- or under-stimulating inflation.

December 26, 2009

What a shock. U.S. GDP is not growing at 3.5% per year, as originally reported, and celebrated with much fanfare from President Obama about how the stimulus program was working. It is not even growing at the revised 2.8% annualized rate reported a couple of weeks later. The latest re-revised figure is 2.2%.

Nearly the entire 2.2% annualized growth, or 3rd quarter growth of 0.55%, is driven by the cash for clunkers program, the government spending program (also called the stimulus program, but I have a big problem with that particular name), and the extended tax credit for first time home buyers. Which means that this increase in GDP is not only entirely temporary and fleeting, but will cause lower GDP later. The cash for clunkers program did not create more overall demand for cars; it simply pulled some of the future demand for a new car into today, all the while wasting millions of tax dollars on administering the program, and putting some dealerships out of business in the process. The spending program simply shifted profits from businesses to support other segments of society, all of which is temporary and destroys the productive capacity of the economy for many periods to come. The extended tax credit to first-time home buyers is a real head-scratcher. A curious time to redistribute funds from the producers in the economy to finance a program which lowers the cost to those home buyers who would not have the funds to buy a home in the first place....second wave of home mortgage foreclosures, anyone?

December 24, 2009

1) Self referential loops have proven a problem in logic. Should not they be a problem in the market, or is it that the market has nothing to do with logic?
The CEO class, in the USA, is self referential.
2) Europe has now more big companies than the USA. Still, big European executives are paid at least ten times less than their USA equivalents. How come the market is so different in Europe? Is the fact that more compensation in Europe goes to talent located on lower rungs of companies, related to the higher performance of European companies in the last decade? After all, the total compensation being finite, paying more for talent at the CEO level means paying less for talent just below.
An interesting aside is that CEO in the USA are much taller than average. Are size and compensation the only way they can dominate their subjects?
A few years ago, Renault was all set to buy General Motors. At the last minute, though, Renault executives learned that GM executives intended to pay themselves more than ten times what Renault-Nissan executives were paid. So Renault scuttled the deal. US taxpayers are left with the bill: more than 60 billion dollars, no? (And GM will fail within a year or two.)
It is true there are markets, and they can deal. But they are more or less free.
There are not just markets. There are also classes too, and they can dominate, with extra market mechanisms. The CEO class in the USA sits on each others’ boards, determining each others’ compensations. In some other countries, this sort of incest is more limited (in others, it’s worse: China). In Germany, union representatives sit on boards.
Generally those who really love their jobs will do them for free. Too much compensation is actually a distraction. And bad markets, thus exists. They are not just bear markets, they can lead to captive markets, and oligarchies…

My reply to Patrice:

Patrice —

Your view of markets is flawed, perhaps fatally so.

The U.S. labor market, for example, provides just the right incentives for individuals to work hard in order to improve the quality of their lives in ways that free people see fit.

There are some issues with that market in its current form, like minimum wage legislation and unions, but overall the U.S. labor market works quite well, particularly when viewed dynamically, through time, instead of as a snapshot at a point in time, as you seem to do.

Your comments ignore the fact that most CEOs work their way up through their companies, or in other companies, for many years, putting in long hours, sacrificing time at home and with family, in order to rise to the top, to take on the huge responsibility of guiding an organization to sustainable profits.

Right this moment, people are toiling away in industry at lower salaries, or in school at no salary, honing their skills, building relationships, learning about their industry, coming up with better ideas. A select few of these people will one day rise to become the CEO of a company, many of which do not even exist today. CEOs earn whatever the labor market, in its objective, efficient way, as disciplined by laws preventing fraud and by the instantaneous referendum on value creation represented by an active capital market, deems is justified.

Yes, there are temporary glitches in the functioning of the labor market, like Enron. Yes, there are unethical executives, like Maddoff.

But the fate of Enron, its executives, and Madoff is glaring proof that the markets in the U.S. work to ferret out the thieves and reward hard-working entrepreneurs and business people.

December 23, 2009

Hi Sherry:I made several points. Indeed by “public utility” I allude to public as in res-publica.Funny you said that a “national interstate roadway system” should be paid by taxes. As I said, in France, it’s private, and paid by the proverbial ‘end user’. So much for France being socialist and USA private profitist. Please forgive the neologism.

I gave the example of waterworks. Private French companies lead worldwide in that domain. That means French (local) government use taxes to pay them. But recently some government realized they could get more services by doing the work themselves. So, in this case, they start as before: taxes. But then, instead of paying some giant private French water company, they pay municipal workers and engineers to do the work. Cost less (less taxes), better service.

Call that an anti-Jarrell universe. A mystery, like anti-matter. How could that happen? Very simple: think about it: the municipal government does not have shareholders (just stakeholders) and does not have to pay dividends, and does not have to increase the value of the shares by showing profits. It actually has no profits to make. So the end user (the denizen of said city under his city government) saves money (i.e., taxes), improves services.

This example, of course carries to health care. France has also a competition of public and private health care systems, large pharmaceutical companies, etc… And has done more face grafts (in public hospitals) than the rest of the world combined… and the first successful gene therapies (also in public hospital), etc. Was is it not to like? If profitist ideologues in the USA were not so greedy, they would see the necessity of having a strong public sector, be it only to keep the private sector honest.

By the way, French politicians are regularly condemned for corruption, and it’s not because they are richer than their colleagues in the USA, by a long shot…

My reply:

Ah Patrice….here we go again! For one, I did not say that government “should” pay for a national highway system, I said that we do pay for a national highway system. A positive statement, not a normative one.

I guarantee you that in any universe – not just the Jarrell one – the true cost of anything paid for by the government with tax dollars is understated by several orders of magnitude. And, possibly, overstates benefits. It is simply factually incorrect to say that the cost (the true economic cost as measured by the use of resources) of providing the service is less when provided by the government. The one-period ACCOUNTING cost put on paper by some government office, as reported to the press, and swallowed whole as fact by readers, may be less. But it is literally, factually impossible for the true costs to be reduced by inserting a redistributive middleman between consumers and business.

You also fail to understand the relationship between stock prices and economic value. You should step back, slow down, and consider the following. Let’s get dollars and stock prices and dividends and profits out of the equation entirely and just think about the amount of goods and services provided versus the amount of resources used up in the production of those services. Measure it however you want — quality of life, health of the citizenry, happiness, kumquats. Now ask yourself which is the most “efficient”method of providing final goods and services, where efficiency is measured, as it should be, as the number of units of output of the good and service provided per unit of resources used up in production process. The “dividends” and “capital gains” in this analogy are the EXTRA value created from a capitalist system; take one input, create 2.5 outputs, added value is 1.5. The government as provider creates zero extra value, if we are lucky, and negative value, if we are realists: take that same input, chew up half its value in bureaucracy, buying votes, and redistributing the consumption decisions of a free people toward something they would not choose to purchase in the first place (otherwise, why the government program in the first place?), and produce 0.5 total outputs, a loss of 0.5. The social loss from moving from capitalism to collective command and control is 2: from plus 1.5 to negative 0.5.

Yes I am including spending on defense and clean air and roads. When we spend on collective goods, we use resources less efficiently. This spending infringes on our economic freedom, but some goods and services are necessary to protect and preserve the system that enables that economic freedom.

You and I can and most certainly do disagree on where to draw the line on what goods and services the government should provide over the objections of a free people, but we cannot disagree on facts. Your claim that government provision of goods and services is less costly than private industry is factually incorrect.

December 22, 2009

Now something related to think about. Why not make American freeways private? The US government could sell the Interstate system, making lots of profits (are not profits the best thing?), then the private owners would make even more profits. No more taxes to pay for the roads, etc… One could extend that to the army. Make the army completely private, headed by the operators of the ex-Blackwater, I mean “Xe”. Army guys would be encouraged to make profits, as their predecessors in France around 1200 CE (interestingly called “Les Grandes Compagnies” = The Great Companies”).

And so on.In France, freeways are actually private, and toll. But of course they were built and paid for by private capital (protected by law recognizing them as of “public utility”). It works well, nobody is complaining: superior surfacing, no holes, no debris, and advanced freeway architecture, differently from American freeways.The high speed train network is according to similar lines.

Superior economic organization is all within that concept of PUBLIC UTILITY.

Profit is not the superior economic organizing principle. Public utility is.

Pirates made profits, so did Roman governors and Persian Satraps, or Carthage.

The USA can learn a lot from its sister republic, France. Another example is waterworks. Starting around 1850, private water companies grew in France. They soon became extremely profitable, and several private French water companies are now the largest water companies in the world.

This worldwide success did not escape the attention of typically suspicious French citizens. Some city engineers noticed that they could do the same cheaper. So, paradoxically, a rebellion against the French water giants has started in France, and some city governments are now running, cheaper and better their own waterworks, after wrestling back control from the private water giants.

It is not whether it is private for profit or government for public which matters. what matters is the maximization of public utility. At least in a democracy. In a banana republic, it’s different, true.

My reply:

Patrice: Just to clarify before I comment, by “public utility” you mean the benefit of the whole of the public? And your focus is on what is being delivered or consumed and how much good that does for the citizen?

I assume your point is the superiority of government supplied goods and services — specifically as it is done in France — over the profit motive of private companies. Again, you miss the point that the government would have no resources to spend without private industry. All the government does is to shift profits around in the economy. Now some of that shifting, like from private profits to public goods (and by public good I mean one where the consumption of the good by one individual does not reduce availability of the good for consumption by others; and that no one can be effectively excluded from using the good, like clean air, national defense or, effectively, a national interstate roadway system), is necessary and desirable. We, as a country, defined the need for public goods in our Constitution, but we have strayed very far away from that ideal over time, to our detriment.

December 20, 2009

Tim Clodfelter of the local Winston-Salem Journal wrote a very interesting piece on the future of brick-and-mortar video stores and video rental places such as NetFlix and Red Hat. I happened to be quoted in the article as an economist (the comment about "reducing the average cost every time we watch a purchased video" was supposed to be a joke!), but actually met up with Tim in my role as mom and pseudo-agent! My 15-year-old daughter was standing in a very long line of young ladies waiting to audition for the Coen Brother's remake of True Grit. Tim was there to get the story on the open casting. I asked him over hoping he would talk to my daughter. He and I got to talking instead, he found out that I was an economics teacher, and pulled out his notes on the Video Store story. He ended up talking to me and several other parents in line, all of whom had a different approach to viewing movies. The resulting article follows http://www2.journalnow.com/content/2009/dec/20/dont-count-video-stores-out-yet/:

Sunday, December 20, 2009

Winston-Salem

Don't count video stores out yet

Journal photo illustration by Richard Boyd II

Here are some of the advantages (and disadvantages) of different methods of renting movies:

Independent video stores

Pros: Can have eclectic selection, more personalized service; helps contribute to local economy. Cons: Few stores left; have to leave home.

National chain

Rent-by-mail DVDs

Pros: Don't have to worry about late fees; large inventory. Cons: Harder to browse; have to wait for movies to arrive in mail.

Vending machines

Pros: Convenient, quick. Cons: Only mainstream titles; still risk late fees; have to leave home.

On-Demand

Pros: No need for a DVD player; quick. Cons: Limited offerings.

Buying movies

Pros: Good way to build a library of favorite films; don't have to pay to watch a movie multiple times. Cons: Can get pricey; storage may become an issue; risky with unfamiliar titles.

By Tim Clodfelter

JOURNAL REPORTER

Published: December 20, 2009

Changes in the video industry have led Carol Baker to diversify the offerings at her store, King Video Station in King, in recent years.

"We're still hanging on," she said. Her store, which began renting videos back in 1983, added tanning beds eight or nine years ago, and also sells lottery tickets and acts as a payment center for Duke Energy.

"We've had to add those things in order to compensate for the loss of video sales," she said. "For the ones who have ample space, it just makes a good mix."

But she is looking forward to the holidays, saying that winter is traditionally a busy time for video rentals.

"During the vacation period between Christmas and New Years' is a good rental period," she said. "Until that, though, everybody is busy shopping." Her store also sells gifts cards during the holidays.

If independent video stores are struggling, it's because there are almost too many options available to consumers.

Once upon a time, the only way to see a movie on your schedule was to drive to the local video store. Now, you can rent movies by mail or watch them in streaming video online or through a device that connects to your TV set. With Redbox, you can rent the movies from a vending machine, many of which are at the front of grocery stores and large retail stores. Cable and satellite have video-on-demand options that offer the latest hits and catalog titles. And many public libraries offer videos for free.

But don't count video stores out just yet, said Shawn DuBravac, the chief economist and director of research for the Consumer Electronics Association.

"I don't necessarily see them going away, but their business models are evolving," he said.

Changing times

The NPD Group, a market research firm, found that video rentals from traditional brick-and-mortar video stores accounted for 47 percent of the rental market between January and October, down from 63 percent in the same period of 2008. Rent-by-mail was 28 percent in 2008 and 33 percent this year; vending machines grew from 9 percent in 2008 to 20 percent this year. The study did not include video-on-demand options.

Video rentals from all sources have declined from a peak of $10.4 billion in 2001 to $8.2 billion in 2008. But the numbers are back on the upswing, said Denis Cambruzzi, the vice president of corporate development at Adams Media Research.

In 2001, traditional video stores accounted for the majority of rentals, with $10.3 billion. That figure dropped to $5.5 billion in 2008.

A report from Adams Media Research found that in 2009 there are still more than 19,000 stores nationwide that specialize in video rentals, a number that declined by more than 3,800 between 2001 and 2008. The number of nonspecialty stores that included video-rental departments, such as grocery stores, fell much more sharply, going from more than 17,000 in 2001 to just 712 in 2008, many of them closing their departments and leasing space to vending machines.

"We've seen a tremendous amount of innovation in delivering video to consumers just in the last two years alone," DuBravac said. "There are different pricing models, delivery methods, and you can pick it up at a convenient location."

Blockbuster, for instance, added a rent-by-mail service several years ago and is installing vending machines around the country. By the end of 2009, the chain will have 2,500 machines nationwide; by the end of 2010, that number is expected to expand to 10,000, according to Michelle Metzger, a spokeswoman for Blockbuster.

Blockbuster also offers video-on-demand through TiVo and some Samsung devices. But the company remains devoted to brick-and-mortar buildings.

"There's still something to be said for the family ritual of going to the video store to rent movies," Metzger said. "We still have over 3,000 stores here in the U.S."

Independents to chains

In the 1980s, there were a number of locally owned video stores in the Winston-Salem area, such as Action Video and Video Village. Over time, national chains such as Blockbuster, Movie Gallery and Family Video moved in, drawing away their business. Now, only a handful of video stores, most of them chains, remain.

And even the numbers of chains are dwindling. One of Blockbuster's Winston-Salem locations, on West Clemmonsville Road, closed this year. Another, at North Point, is in the process of closing, selling off its inventory and moving employees to another location.

Kaisha and Kelvin Jones of Winston-Salem were loyal customers at the North Point Blockbuster.

"We're movie fanatics," said Kaisha Jones as she browsed through the used DVDs on sale at the store. "We have small kids, and it's expensive to go to a movie theater."

She said they have tried Blockbuster's online rent-by-mail service, but found that they were coming into the store more often.

"They have real nice clerks giving customer service," she said. "And you run into friends while you're here. I'm still a people person."

They use Redbox as a backup, but, Kelvin Jones said, "There's more of a selection here."

They plan to switch back to Blockbuster Online, but said that they would miss the store.

Rent by mail

Rudy Schmidt, a retiree from Clemmons, said she prefers Netflix. She said that rental stores "are too expensive, and it's a pain in the neck to bring stuff back."

With Netflix, she said, "you can hang onto it as long as you want, and get the movies in what order you want them."

She subscribes to one of the least expensive Netflix plans, allowing her to rent one DVD at a time for $8.99 a month. She returns one disc and gets the next usually within two days. Options are available for renters to get as many as eight discs at a time, which costs $47.99 a month. But the most common plans are for up to three movies at a time for $16.99 a month.

Netflix started in 1997 and now has more than 10 million subscribers who can access up to 100,000 titles. There are more than 50 distribution centers in the United States, the closest being in Greensboro; if a title is not available at the nearest hub, it will be sent from farther away.

A few specialty video stores, such as Video Vault in Alexandria, Va., offered rentals by mail in the age of videotapes. But rental costs were high because of shipping expenses. DVDs and Blu-rays are much smaller than tapes and easier to mail, which made Netflix and similar services such as Greencine and Blockbuster Online viable.

"Netflix continues to grow, and video stores continue to decline," said Steve Swayze, the vice president of corporate communications with Netflix. He said that the company has had 28 percent year-over-year growth. Of its 100,000 titles, 17,000 are also available as streaming video.

Rent by box

Redbox, which started in 2004, focuses more on the current hits, with each kiosk holding 150 to 200 titles. The kiosks are found in more than 17,500 locations nationwide, including Wal-Mart, grocery stores and McDonald's. Rentals cost $1 a night.

According to a company spokesman, Redbox rents more than 1 million DVDs each day. Though most of its titles are new releases, the company says that it does carry some popular classics and children's titles in response to customer feedback.

Laurie Hardin, a Winston-Salem resident, said she frequents Redbox machines at Harris Teeter stores, combining trips to the grocery store with video runs. She has been using Redbox for six months and uses an online option that lets customers reserve titles before they come in the store.

"I love it," she said of Redbox. "If they ever took it away, I'd be heartbroken."

Sherry Jarrell, who teaches economics and finance at Wake Forest University, said she can't imagine traditional video stores making a comeback.

"Brick-and-mortar stores are having an uphill battle," she said. "It's so convenient (online). The availability is higher online and the costs are lower. Once people switch, they never go back."

Jarrell doesn't use Net flix or Redbox, but goes with another option: She buys most of her movies rather than renting them. "I don't like the hassle and late fees," she said. "I have a big collection, and we like having them and being able to re-watch them."

Plus, the more times that she watches a movie, she said, the more cost-effective it is to buy it.

DVDs have a different business model than videotapes. Videotapes were initially released for the rental market, with prices averaging $60 to $70 a tape, so stores would buy them to rent out to customers; about four to six months later, the cost would drop to a retail price in the $20 range so individuals could buy them. But DVDs are sold at retail prices, generally $15 to $25, at the same time they come out for rent, making them a more attractive option to buy.

Rent on demand

DuBravac said that the rental world will be undergoing even more change in years to come.

The Consumer Electronics Association expects digital-streaming video to grow more popular in the next few years. Netflix streaming videos can be watched on a computer or on a TV set that is equipped to show Web content, or one that has a Netflix-compatible Blu-ray player or PlayStation 3.

Another streaming video option is video-on-demand, or VOD, which is available through cable services and some satellite providers. Time Warner Cable has seen steady increases in its video-on-demand in the past few years, said George Douglas, the vice president of marketing for Time-Warner Cable's Carolinas region.

"One of the things that really ramped up use of VOD pretty heavily was when we added free On-Demand," Douglas said. Those included content from channels such as CNN, Golf Channel and Cartoon Network.

The company now has an average of 5,800 hours of on-demand programming available on 50 channels in the Triad. The average customer, he said, watches four to five video-on-demand programs each month, ranging from music videos to movies.

Despite the changes in recent years, DuBravac said that physical media -- DVDs and Blu-ray discs -- will remain in the equation whether they are rented, ordered through the mail or picked up at vending machines.

"One thing we know," he said, "is consumers will have access to more content than they know what to do with."

December 18, 2009

The Federal Reserve, or Central Bank, is the banking
system’s bank. It is the lender of last resort. It is through the Central Bank
that banks settle their accounts with each other. The central bank serves as a
clearinghouse for checks written by depositors, and it holds the commercial
banks’ reserves. Bank reserves (vault
cash, and deposits by banks at the Central Bank or the Fed) are monies held out
of circulation by banks to satisfy the Fed’s reserve requirements and the
currency demand by the public. Excess reserves are those held above the legal
reserve requirements to handle uncertain demand. Bank deposits not held in (required plus
excess) reserves are used to make loans and earn interest.

When banks make loans, they do not actually lend out the
equivalent in cash but instead create on their balance sheet a loan asset and
an equal liability called a demand deposit.
Such lending by banks is limited only by reserve requirements (set by
the Fed) and the cash they need to satisfy cash withdrawal demand by their
customers. As these loans are then
re-deposited by the borrower, the multiplier process continues as fractional
reserves are held back and the balance is “lent” out again.

So when the Fed begins to pay interest on excess reserves, it not only reduces lending, but shrinks the money supply and the liquidity it represents by a multiple of the funds not lent.